Indonesia’s local-currency bonds have gone from Asia’s best performers to the worst as the weakening rupiah and the region’s lowest real yields harm returns.
Sovereign notes have fallen 2 percent in March after leading the region in the first two months with an 8.4 percent advance. The rupiah dropped 5.3 percent to 13,076 a dollar in 2015, the worst performance in Asia after Malaysia’s ringgit, and the median estimate of analysts surveyed by Bloomberg is for a decline to 13,450 in a year.
While President Joko Widodo has scrapped gasoline subsidies and pledged to cut red tape to woo investment since taking office in October, his anti-graft credentials took a hit after he had to withdraw his pick for police chief due to a corruption investigation. As his honeymoon period ends, investors are refocusing on his challenges including the fastest inflation among Asia’s 10 biggest emerging-market economies and the widest current-account deficit.
“I was quite positive on Indonesia for a long time but the reason I turned negative is a lot of the good news has been priced in,” Bhanu Baweja, the London-based head of emerging- markets cross-asset strategy at UBS, Switzerland’s largest bank, said in a March 24 phone interview. “The rupiah will infect the bond market.”
Indonesia’s benchmark 10-year yield has fallen 37 basis points, or 0.37 percentage point, this year to 7.43 percent, Inter-Dealer Market Association prices show. After accounting for inflation of 6.29 percent in February, the real yield on the debt is 1.14 percent. That compares with 3.79 percent for Malaysia, 3.19 percent for Thailand and 1.56 percent in the Philippines.
“Compared to its peers, Indonesia’s real yields are not compelling at the moment,” Nagaraj Kulkarni, a senior rates strategist at Standard Chartered in Singapore, said in a March 24 phone interview. “We would like it if the real yield is upward of 150 basis points.”
The rupiah has fallen 2.5 percent since Feb. 16, a day before the central bank unexpectedly cut its policy rate for the first time in three years. The 25-basis-point reduction to 7.5 percent contributed to outflows of Rp 7.04 trillion ($538 million) from local-currency sovereign debt so far this month, finance ministry data show. The Indonesian currency touched a 16-year low of 13,248 a dollar on March 17.
“Our concerns lie with the currency at this juncture,” Mark Capstick, a London-based portfolio manager at BNP Paribas Investment Partners, which oversees 514 billion euros ($557 billion), said in a March 24 e-mail interview. “Emerging-market currencies have certainly come under pressure while participants assess the pace of the removal of monetary accommodation in the US. This is why people are questioning whether rate cuts are the sensible policy at the moment.”
Bank Indonesia will ensure that currency fluctuations will be in a manageable range, governor Agus Martowardojo told reporters in Jakarta on March 27. The central bank is targeting 2015 inflation of 3 percent to 5 percent, it said this month.
HSBC Global Asset Management, which oversees $454 billion globally, still likes Indonesian sovereign bonds as inflation is forecast to ease and the central bank will have room to reduce interest rates, Gordon Rodrigues, its Hong Kong-based head of Asian rates and currencies, said in a March 25 e-mail interview.
Rupiah government notes are susceptible to sell-offs because of high offshore ownership. Foreigners own 39.6 percent of the debt, according to the latest Asian Development Bank data, compared with 30.9 percent in Malaysia and 18.3 percent in Thailand.
Adding to Indonesia’s vulnerability as the Federal Reserve moves toward raising interest rates, is a current account that’s been in shortfall for 13 quarters through the end of last year, helping drive a 29 percent plunge in the rupiah over the period. The country recorded a deficit of 2.95 percent in the broadest measure of trade last year.
Southeast Asia’s largest economy expanded 5.02 percent in 2014. The government is targeting 5.7 percent growth this year, while the World Bank is forecasting 5.2 percent. President Joko wants to boost annual expansion to 7 percent before the end of his five-year term.
“I do expect it will sell off again,” UBS’s Baweja said. “This is a central bank that would want to maintain growth at a reasonable level, which means they’ll be happy to let the currency depreciate a little bit more and that means they’re going to get inflation a little bit higher.”